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Iceland’s Financial Crisis: A Lesson in Negligence and Fraud

October 7th, 2008 marked a turning point in Iceland’s financial history. Landsbanki, one of the country’s three major banks, failed to meet British Financial Services Authority (FSA) requirements due to insufficient funds, resulting in authorities taking control of its UK operations.

The Crisis Unfolds

The crisis was exacerbated by Kaupthing Singer & Friedlander’s (KSF) failure to meet margin calls after the value of collaterals underlying KSF lending to Kaupthing fell. The parent company’s response to movements of £500 million to Iceland only hastened the collapse, prompting British authorities to take control of KSF on October 9th, 2008.

A Nation’s Debt Crisis

Iceland’s debt-free state found itself without credit in early 2008, leading to suggestions that it turn to the International Monetary Fund (IMF). However, strict austerity measures were implemented instead, further straining the economy.

Accountability and Lessons Learned

The Special Investigation Commission (SIC) has shed light on the mistakes and negligence of ministers and public officials. Former Prime Minister Geir H. Haarde, Minister of Finance Árni M. Mathiesen, and other high-ranking officials have been found guilty of negligence in their handling of the crisis.

Bankers have been accused of fraud and market manipulation. Kaupthing’s CEO, Chairman, Controlling shareholder, and CEO of Kaupthing Luxembourg were sentenced to 3-5 years in prison for fraudulent lending practices and market manipulation, while cases against Landsbanki management are pending.

Key Lessons

The SIC has highlighted several key lessons:

• Importance of Equity: Monitor leverage and ensure that banks maintain sufficient equity.
• Banker’s Claim on Holding Companies: Understand the claim on residual assets and price accordingly.
• Supervision Built on Economic Substance, Not Legal Form: Ensure that supervision is based on spirit of the law rather than just the letter.
• Design of Incentive Schemes Matter: Incentivize responsible behavior and discourage reckless risk-taking.

Medium-Term Effects

The medium-term effects of the crisis have been severe:

• Broken Markets: The bond, stock, and currency markets were severely impacted.
• Order of Claims Altered: The collapse has led to difficulties in funding new banks.

Conclusion

As Iceland navigates its recovery, it is crucial that these lessons are learned from and implemented to prevent similar crises in the future.